Momentum trumps fundamentals

ONE of the most valuable pieces of trading advice I ever received was during the early days of my finance career in Hong Kong: “Emphasise price action over fundamentals; align your positions with the market, rather than opposing it. When price and fundamentals are in conflict, price wins.”

The current price action of oil illustrates this point. Since the Israel-Hamas war began in October 2023, oil prices have fallen by 16 per cent. This price action suggests that markets may not be anticipating an escalation in this war.

Similarly, the price reversal after equities boomed in early November 2023 was swift and triggered many positive momentum indicators, bringing indices close to regaining their all-time highs.

Investors, however, remain cautious and are concerned about downside risks for the year. The war shows no end in sight. China’s economy continues to weaken, starting the new year with a sharp drop as manufacturing activity contracted further in December to the lowest level in six months, while home sales continue to be weak.

Moreover, this year will see elections in at least 64 economies, involving 46 per cent of the world’s population and nearly 80 per cent of the world’s stock market capitalisation. These commenced with Taiwan this past weekend, and will be followed by India in the spring, ending with the most pivotal of all, the United States.

These closely contested elections, carrying significant geopolitical implications, are poised to magnify uncertainty in financial markets.

Meanwhile, economists have firmly embraced the soft-landing narrative, a stark contrast to their universal bearish outlook and recession predictions last year, which did not happen.

Leading economic indicators (LEIs), forward-looking economic data that is used to gauge the future state of the economy, have been consistently negative in the US, and from Bloomberg analysis we can see that:

• LEIs declined 12 per cent over the course of two years. There has never been this deep a decline without a recession.
• LEIs dropped for 20 consecutive months. This has never happened without a recession.
• LEIs fell year on year by 7.6 per cent. There has never been this deep a decline without a recession.

And yet, a recession did not materialise. If you’re in this game long enough, you’ll see every indicator eventually loses its usefulness. While we may get an economic slowdown this year, a deeper recession does not seem to be on the cards.

Investors’ cautious mood can be seen in recent money flows.

According to Strategas investment research, US exchange traded funds pulled in US$388 billion last year, but money market vehicles, the most boring investments possible, pulled in over US$1.1 trillion.

There is currently over US$4 trillion on the sidelines in cash, an all-time high.

Many investors continue to hedge downside risk from a recession. No one I talk to is anticipating a strong year for equities.

The leading story of 2023 was how the Magnificent Seven drove all the returns of the S&P 500 index. But this changed after the end-October low, as the rally broadened to other sectors.

The rally has widened to include an extremely high percentage of stocks moving up together, which is how many sustainable rallies begin.

This broadening has been so widespread that it has triggered many momentum buy signals, all of which have bullish implications for this year’s stock market performance. Below are three of the strongest ones:

• Seventy per cent of the US market was at 20-day highs. This is a rare signal, telling us that the broader market is in line with the gains made by the index; that is, it’s the opposite of a narrow market led by the Magnificent Seven.
• A stock index hitting a record high generally makes investors nervous. However, in 13 out of the 14 times when equities made a new all-time high over the last 70 years, they gained a median of 13.4 per cent one year later. The single loss was the all-time high in 2007 before the global financial crisis.
• The percentage of stocks above their 50-day average hit 87.8 per cent, almost at the 90 per cent threshold. At readings above 90 per cent, stocks have had a mean return of 8.47 per cent a year later, with no down years.

In rare cases when momentum is as strong as we have witnessed, median returns have been at least twice the long-term average up to a year later.

All these indicate that in the short term, equities are very overbought, and a pullback would be normal.

More importantly, they also suggest that 2024 will be a better year for equity performance than most investors expect.

The writer is head of investments for Singapore at AlTi Tiedemann Global. The views are solely the author’s and do not reflect the views or positions of AlTi Tiedemann Global or its subsidiaries. This content should not be considered as financial advice.